What does diversification in investing involve?

Diversification in investing involves spreading investments across various asset classes to reduce risk. The underlying principle of diversification is that different asset classes often respond differently to economic events. By investing in a mix of asset types—such as stocks, bonds, real estate, and cash—an investor can minimize the impact of any one investment’s poor performance on the overall portfolio.

When one asset class is underperforming, another may be doing well, which helps stabilize returns over time. This approach lowers the overall risk because the volatility of the combined assets is less than that of any single asset.

Investing in a single asset class, which might seem tempting due to potential high returns, exposes an investor to greater risk since their portfolio would be more vulnerable to market fluctuations. Similarly, exclusively investing in stocks or focusing solely on high-risk investments does not harness the full potential of risk management that diversification can offer. Thus, incorporating a variety of asset classes helps investors achieve a more balanced and resilient portfolio.